What Is a Special Needs Trust?

Quick Answer

A special needs trust is a legal entity that holds financial assets on behalf of a disabled person. The purpose is to put a barrier between the special needs individual and the assets they receive or inherit to ensure they can remain eligible for government benefits such as Social Security or Medicaid.

A grandmother in a wheelchair talks with her two granddaughters as their mother holds them.

If you're the parent or guardian of someone with special needs, you may feel anxiety about whether they will be cared for if you're no longer able to support them. Fortunately, with some planning and professional help, there are many ways parents of someone with special needs can financially prepare for a secure future for their child and themselves.

One key way to do this is to create a special needs trust, which allows a person to leave money or property to their loved one with a disability without affecting their eligibility for government assistance programs.

How a Special Needs Trust Works

Social Security and Medicaid provide invaluable income and medical coverage for those with disabilities. However, these programs typically require the recipient to have low or no income, and minimal assets.

If there is no special needs trust in place, a person with disabilities who has some assets—whether due to a court settlement or family assistance or inheritance—might not be eligible for government assistance.

Rather than leaving assets directly to your loved one, a special needs trust allows you to put them in a trust, which is a legal entity managed by someone you appoint as the trustee. The trustee can't give the funds directly to the loved one, since this can jeopardize their eligibility for government benefits. Instead, the trustee can spend the money on an assortment of expenses for the disabled person that aren't covered by Social Security or Medicaid.

Allowed expenses include purchases such as one primary residence, one car, caregiving services, education, home furnishings, travel and medical services that aren't offered under Medicaid. An individual in possession of over $2,000 in assets not included in the allowable expenses is no longer eligible for Social Security. This is why it's important to not give the beneficiary cash or investments from the trust directly.

Types of Special Needs Trusts

Special needs trusts can be created for children, but in some cases, they can also be created for grandchildren, siblings or even aging parents. These are the three types of special needs trusts:

  • Third-party special needs trust: This type of trust is often used for estate planning purposes, as it is not funded by the beneficiary. While third-party trusts are commonly created by the parent of a disabled person, any third party to the beneficiary (such as a sibling) can create the trust. A stand-alone special needs trust can be set up while the parent or guardian is still alive, and funded with gifts from various family members. Or it can be included in a will and only funded once the trust's creator passes away and leaves money in it as an inheritance.
  • First-party special needs trust: This type of trust is often used for disabled people who already inherited money or own property, or who receive a court settlement. The only people who can create one are the beneficiary's parent, grandparent, legal guardian or a court. A first-party special needs trust is only for those under age 65, and they must meet the government's definition of disabled.
  • Pooled special needs trust: If you're not able to find someone to be the trustee or you're not working with a large amount of money, one option is to participate in a pooled trust. Some nonprofits will pool funds from different families, and while each trust beneficiary's sub-account is separate, the nonprofit manages everything at a lower cost and selects a professional trustee.

While it can vary based on the type of trust, a trust typically ends either when the beneficiary dies or when all of the funds in the trust are exhausted.

Benefits of a Special Needs Trust

What is the purpose of a special needs trust? While this legal and financial tool can seem confusing at first, it offers many benefits:

  • It allows parents or other family members to ensure their estate planning sets up their disabled loved one with financial resources for the future.
  • It prevents the person with special needs from being disqualified for important government benefits such as Social Security or Medicaid.
  • It helps secure a disabled person's inheritance or court settlement by someone you trust.
  • It prevents the disabled person from having to manage money themselves, and because they aren't directly involved with the funds, their risk of being exploited is reduced.

How to Set Up a Special Needs Trust

While you can create a special needs trust yourself, it's ideal to hire an attorney to draft one, especially since laws can vary by state. Here are the steps to take to set up a special needs trust:

  1. Decide what type of special needs trust your family requires. If it's a pooled trust, you can contact an organization that specializes in them. If you want to create a third-party trust but can't afford a lawyer, NOLO offers a guide on creating one yourself.
  2. If you plan to create a first-party or third-party special needs trust that's not pooled, and you can afford it, it's best to hire an attorney or special needs planner who specializes in this area. If you haven't yet done your estate planning, you could find an estate planning lawyer and create the trust along with other important documents such as your will and powers of attorney.
  3. With the advice of a professional, decide what type of special needs trust to set up, who the trustee will be and how it will be funded.

Protecting Everyone's Financial Future

Coping with a disability is challenging in countless ways, but hiring a professional and creating a special needs trust is a powerful tool to ensure your child or other loved one has the resources and benefits they need throughout their life.

It can also help you, as the parent or guardian, to better plan your own financial future. When there's a disability in the family, unexpected expenses can happen, which can sometimes result in debt or damaged credit. In addition to creating a special needs trust, it's ideal to stay on top of budgeting, monitoring your credit (free with Experian) and keeping debt manageable to protect your finances and those of your loved one.

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